Article by Linda Z. Swartz and Jean Marie Bertrand *

I. TAX SHELTER REGULATIONS

A. Overview

  • Disclosure requirements for participants in "reportable transactions."
  • List-maintenance requirements for "material advisors" with respect to reportable transactions.
  • Disclosure requirements for "material advisors" with respect to reportable transactions.1

II. TAX SHELTER DISCLOSURE REQUIREMENTS FOR PARTICIPANTS

A. Overview

  • Categories of Reportable Transactions2
  • Listed Transactions

    • Confidential Transactions
    • Loss Transactions
    • Contractual Protection Transactions
    • Transactions of Interest entered into on or after November 2, 2006
    • Patented Transactions would constitute a new category of reportable transaction under proposed regulations.3

  • Participant Reporting Obligations

    • Every taxpayer "participating" in a reportable transaction that is required to file a U.S. tax return must:4

      • Mail IRS Form 8886 to the IRS Office of Tax Shelter Analysis for the first year the taxpayer participates in the transaction,
      • Attach IRS Form 8886 to its tax return (and any amended return) for each year in which the taxpayer participates in the transaction,5 and
      • Retain a copy of all documents and other records related to the reportable transaction that are material to an understanding of the tax treatment and tax structure of the transaction until the statute of limitations runs.6 However, taxpayers are not required to retain non-substantive emails and other documents that are not material to the tax treatment or tax structure of the transaction. Taxpayers are also not required to retain earlier drafts of a document if they retain a copy of the final document (or, absent a final document, the most recent draft of the document), and such final document (or most recent draft) contains all the information found in earlier drafts that is material to an understanding of the purported tax treatment or tax structure of the transaction.7

    • A taxpayer's failure to properly disclose a reportable transaction is a strong indication that the taxpayer did not act in good faith with respect to the transaction for purposes of the general reasonable cause and good faith exception to the accuracy related penalty.8 Moreover, a taxpayer that has not adequately disclosed a reportable transaction in accordance with the tax shelter regulations may not rely on the adequate disclosure exception to the accuracy related penalty for disregard of rules and regulations.9 Finally, the regulations deny the "realistic possibility" defense for a taxpayer that disregards a revenue ruling or notice with respect to a reportable transaction.10
    • If a taxpayer requests a ruling on the merits of a specific transaction on or before the date disclosure would otherwise be required, and receives a favorable ruling as to the transaction, the disclosure rules will be satisfied if the ruling request fully discloses all relevant facts relating to the transaction which would otherwise be required to be disclosed.11
    • If a taxpayer requests a ruling as to whether a specific transaction is a reportable transaction on or before the date that disclosure would otherwise be required, the IRS commissioner in his discretion may determine that the request satisfies the disclosure rules if the ruling request fully discloses all relevant facts relating to the transaction which would otherwise be required to be disclosed.12

      • However, the taxpayer's potential disclosure obligation is not suspended while the ruling request is pending.13

    • A protective disclosure filed with respect to a potentially reportable transaction that complies with all disclosure requirements would satisfy a taxpayer's potential obligation to disclose the transaction.14

  • In the case of a taxpayer who is a partner in a partnership, a shareholder in an S corporation, or a beneficiary of a trust, the disclosure statement must be attached to the entity's return for each taxable year in which the entity participates in a reportable transaction.15

    • If a taxpayer receives a timely Schedule K-1 less than 10 calendar days before the due date of the taxpayer's return (including extensions), the taxpayer must file the disclosure statement with the OTSA within 60 calendar days after the due date of the taxpayer's return (including extensions).16

  • If a transaction becomes a listed transaction (discussed in Section II.B., below) or a transaction of interest (discussed in Section II.F., below) after the filing of a taxpayer's return (including an amended return), but before the end of the period of limitations for the taxpayer's final return reflecting the listed transaction, the taxpayer must file a disclosure statement with the OTSA within 90 calendar days after the date on which the transaction became a listed transaction or transaction of interest, whether or not the taxpayer participated in the transaction in that subsequent year.17
  • If a transaction becomes a loss transaction (discussed in Section II.D., below) because the losses equal or exceed the threshold amounts, a disclosure statement must be filed as an attachment to the taxpayer's tax return for the first taxable year in which the threshold amount is reached and to any subsequent tax returns that reflect any amount of loss from the transaction.18

B. Listed Transactions

  • A listed transaction is defined as any transaction the IRS designates as a tax avoidance transaction and identifies in published guidance as a listed transaction (and any "substantially similar" transaction).19

    • A "substantially similar" transaction is any transaction that is either factually similar to or based on a tax strategy that is the same as or similar to a transaction described in published guidance and is expected to obtain the same or similar types of tax consequences. The regulations provide that the term "substantially similar" must be broadly construed in favor of disclosure. Receipt of an opinion concluding that the tax benefits from the taxpayer's transaction are allowable is disregarded in determining whether the taxpayer's transaction is the same as, or substantially similar to, a listed transaction.20

  • A taxpayer "participates" in a listed transaction if the taxpayer's tax return reflects tax consequences or a tax strategy associated with a listed transaction (or the taxpayer "knows or has reason to know" that its tax benefits are derived directly or indirectly from a listed transaction).21 "Tax benefits" include any deduction, deferral, basis adjustment, or any other tax reduction achieved by affecting the amount, timing, character, or source of any item of income, gain, expense, loss, or credit.22
  • The IRS periodically publishes a notice in the Internal Revenue Bulletin that updates the compiled list of all transactions it has identified as "listed transactions."23

C. Confidential Transactions

  • Prior regulations broadly defined a confidential transaction to include any transaction offered to a taxpayer under conditions of confidentiality, but also presumed that a transaction was not a confidential transaction if the transaction documents contained a "tax confidentiality waiver."24
  • In response to significant criticism regarding the breadth of the confidential category of reportable transactions,25 the IRS issued regulations in 2004 that significantly narrowed the definition of a confidential transaction.26
  • A transaction is not treated as a confidential reportable transaction solely by reason of confidentiality limitations imposed by a principal to a transaction acting as such.27 Instead, a transaction is treated as a confidential reportable transaction only if (i) an "advisor" limits the taxpayer's ability to disclose the tax treatment, or the tax structure, of the transaction, (ii) the advisor imposing the limitation is paid a fee of at least $50,000 ($250,000 if the taxpayer is a corporation or a partnership or trust with solely corporate owners or beneficiaries), and (iii) the limitation on disclosure protects the confidentiality of the advisor's "tax strategies."28

    • Query: What is a "tax strategy"? For example, government representatives have observed that a tax strategy may include routine statements made in tax disclosure, or made to principals (e.g., a partnership will be treated as a partnership for tax purposes).

  • A taxpayer "participates" in a confidential transaction if the taxpayer's tax return reflects a tax benefit from the transaction and the taxpayer's disclosure of the tax treatment or tax structure of the transaction is limited in the manner described.29
  • Because the term "advisor" is not defined in the regulations and has the potential to be interpreted quite broadly, many law firms and financial intermediaries continue to include tax confidentiality waivers in their documents to ensure non-confidentiality.

    • Query: What is an "advisor"? Presumably an advisor includes any attorney, accountant, investment banker, or other individual that is paid a fee for advice regarding a "tax strategy." Can it include a principal who discusses a tax strategy that affects deal pricing with other parties?
    • Query: Will some or all fees received by an advisor that also participates in the transaction as a principal be considered received in that person's capacity as principal?30 Will a specific allocation of fees be respected? When will a person with two roles be treated as imposing confidentiality as an advisor rather than as a principal?

  • A proprietary or exclusive transaction will not be treated as confidential if the advisor confirms to the taxpayer that there is no limitation on disclosure of the tax treatment or tax structure of the transaction.31

    • Query: What does it mean to "impose" confidentiality by limiting disclosure? Government representatives have agreed that if an advisor confirms to the taxpayer that there is "no limitation on disclosure of the tax treatment or tax structure of the transaction, other than limitations imposed by the SEC, other regulatory bodies, or under the law," that confirmation should satisfy the regulations since the advisor has only referenced (but has not personally imposed) third party limitations on such disclosure.
    • Query: What result obtains if an advisor imposes confidentiality on an opposing principal party, but not on its own client acting as a principal?
    • Query: If an advisor permits the disclosure of the tax treatment and tax structure of a transaction, but imposes confidentiality on all other facts, including, for example, the advisor's investment strategy, will the transaction be considered confidential for purposes of the regulations?
    • Query: Does a limitation on opinion reliance (e.g., only the addressee is permitted to rely) constitute confidentiality?
    • Query: Will confidentiality imposed by an advisor for only a limited period of time, i.e., during initial negotiations, now cause a transaction to be considered confidential?

  • Ordinary course transactions such as debt and equity offerings, cash purchases and sales of stock and assets, and executive compensation arrangements should not be considered confidential transactions reportable by the participants, because they do not involve tax advice provided for a fee by an advisor imposing confidentiality. This result should obtain even if the tax consequences of such a transaction are set forth in disclosure, as long as no fee is paid for advice regarding a tax strategy. However, more complicated transactions, including certain M&A deals, joint ventures, and investment fund offerings, may include advisory fees (including fees embedded in returns paid to principals) and if so, those transactions should also include confidentiality waivers.
  • Persons treated as related parties under section 267(b) or section 707(b) are treated as the same person for the purposes of confidential transaction rules.32

Footnotes

* The authors are grateful to Karen Gilbreath and David Miller for their contributions to an earlier version of this outline and to Stanley Barsky and Jennifer Wetzel for their excellent updates.

1 On October 22, 2004, President Bush signed into law the American Jobs Creation Act of 2004 (the "JOBS Act"), which substantially increased the penalties and sanctions for failing to comply with the tax shelter regulations. In addition, the JOBS Act repealed the tax shelter registration requirements and created new reporting requirements for material advisors.

2 The fact that a transaction is a reportable transaction does not affect the legal determination of whether the taxpayer's treatment of the transaction is proper. Treas. Reg. § 1.6011-4(a).

3 Prop. Treas. Reg. § 1.6011-4(b)(7), 72 Fed. Reg. 54615 (Sept. 25, 2007).

4 Treas. Reg. § 1.6011-4(a), (d).

5 If a reportable transaction results in a loss which is carried back to a prior year, the disclosure statement for the reportable transaction must be attached to the taxpayer's application for tentative refund or amended tax return for that prior year. Treas. Reg. § 1.6011-4(e)(1).

In addition, the taxpayer must include the "reportable transaction number" received from material advisors with respect to the transaction on the Form 8886. Treas. Reg. § 1.6011-4(d).

6 Treas. Reg. § 1.6011-4(g). The term "transaction" includes all of the factual elements relevant to the expected tax treatment of any investment, entity, plan, or arrangement, and includes any series of steps carried out as part of a plan. Treas. Reg. § 1.6011-4(b)(1).

The documents may include (i) marketing materials related to the transaction, (ii) written analyses used in transaction related decision-making, (iii) transaction related correspondence and agreements between the taxpayer and any advisor, lender, or other party to the reportable transaction, (iv) documents discussing, referring to, or demonstrating the purported or claimed tax benefits arising from the reportable transaction, and (v) any documents referring to the business purposes for the reportable transaction. Treas. Reg. § 1.6011-4(g).

7 Treas. Reg. § 1.6011-4(g).

8 Treas. Reg. § 1.6664-4(d).

9 Treas. Reg. § 1.6662-3(a).

10 Treas. Reg. § 1.6662-3(a).

11 Treas. Reg. § 1.6011-4(f)(1).

12 Treas. Reg. § 1.6011-4(f)(1).

13 Treas. Reg. § 1.6011-4(f)(1).

14 Treas. Reg. § 1.6011-4(f)(2).

15 Treas. Reg. § 1.6011-4(e)(1).

16 Treas. Reg. § 1.6011-4(e)(1).

17 Treas. Reg. § 1.6011-4(e)(2)(i).

The statute of limitations on assessment of tax is generally three years after the later of the due date for filing a tax return or the date on which the taxpayer files its return. I.R.C. § 6501(a). Section 6501(c)(10) provides an exception to the general three-year period of limitations for certain listed transactions.

If the obligation to disclose a post-filing listed transaction arises after the expiration of the period of limitations on assessment for a taxable year in which the taxpayer participated in the post-filing listed transaction, section 6501(c)(10) will not reopen or extend the limitations period. However, if the limitations period on assessment has not expired, and the taxpayer fails to disclose the post-filing listed transaction as required by the regulations under section 6011, Section 6501(c)(10) provides that the limitations period on assessment with respect to the undisclosed listed transaction will not expire earlier than one year after the taxpayer discloses the transaction. See generally, Rev. Proc. 2005-26, 2005-1 C.B. 965.

Section 6404(g)(1) generally suspends the imposition of interest, penalties, additions to tax, or additional amounts if the IRS does not contact a taxpayer with possible adjustments to the taxpayer's liability within a certain time period. However, the suspension generally does not apply to interest, penalties, etc. with respect to a listed transaction or an undisclosed reportable transaction. I.R.C. § 6404(a)(2); Treas. Reg. § 301.6404-4(b)(5).

18 Treas. Reg. § 1.6011-4(e)(2)(ii).

19 Treas. Reg. § 1.6011-4(b)(2).

20 Treas. Reg. § 1.6011-4(c)(4). The regulations also contain examples of transactions that are the same or substantially similar to listed transactions.

21 Treas. Reg. § 1.6011-4(c)(3)(i)(A).

22 Treas. Reg. § 1.6011-4(c)(5); Treas. Reg. § 1.6011-4(c)(6).

23 For the current list of all identified "listed transactions," see Notice 2009-59, 2009-31 I.R.B. 170.

24 Treas. Reg. § 1.6011-4(b)(3) (revised Dec. 29, 2003).

Our firm's standard tax confidentiality waiver provided as follows:

Notwithstanding anything to the contrary contained in this Agreement, all persons may disclose to any and all persons, without limitations of any kind, the U.S. Federal, state or local tax treatment of the Transaction, any fact that may be relevant to understanding the U.S. Federal, state or local tax treatment of the Transaction, and all materials of any kind (including opinions or other tax analyses) relating to such U.S. Federal, state or local tax treatment, other than the name of the parties or any other person named herein, or information that would permit identification of the parties or such other persons, and any pricing terms or other nonpublic business or financial information that is unrelated to the U.S. Federal, state or local tax treatment of the Transaction to the taxpayer and is not relevant to understanding the U.S. Federal, state or local tax treatment of the Transaction to the taxpayer.

25 See, e.g., Bond Market Association's Comments on the Final Tax Shelter Regulations, 2003 TNT 108-16 (June 5, 2003).

26 For comments addressing the revisions to the confidentiality provisions, see NYSBA Comments on Disclosure Regulations, 2004 TNT 33-18 (Feb. 18, 2004); Udrys, Reeder and Church, The Revised Confidentiality Filter: Top 12 Practical Implications, 2004 TNT 46-8 (Mar. 8, 2004).

The IRS revised the final regulations in August 2007, but the principal change from the 2004 regulations appears to be the addition of a statement that the government will closely scrutinize all of the facts and circumstances to determine whether consideration received in connection with a confidential transaction constitutes fees. Treas. Reg. § 1.6011-4(b)(3).

27 T.D. 9108, 2004-1 C.B. 429.

28 Treas. Reg. § 1.6011-4(b)(3). The "tax treatment" of a transaction is the purported or claimed Federal income tax treatment of the transaction, and the "tax structure" of a transaction is any fact that may be relevant to understanding the tax treatment of the transaction. Treas. Reg. § 1.6011-4(c)(8), (9).

The regulations do not define the terms "tax strategies" or "tax advisor."

29 Treas. Reg. § 1.6011-4(c)(3)(i)(B). If a partnership's, S corporation's, or trust's disclosure is limited and a partner's, shareholder's, or beneficiary's disclosure is not, "participation" occurs only at the entity level. Treas. Reg. § 1.6011-4(c)(3)(i)(B). If both the entity and its partner's, shareholder's, or beneficiary's disclosure are limited, "participation" occurs at both levels. Treas. Reg. § 1.6011-4(c)(3)(ii), example 2.

30 The regulations provide that:

. . . all fees for a tax strategy or for services for advice (whether or not tax advice) or for the implementation of a transaction are taken into account . . . . A fee does not include amounts paid to a person, including an advisor, in that person's capacity as a party to the transaction. For example, a fee does not include reasonable charges for the use of capital or the sale or use of property. Treas. Reg. § 1.6011-4(b)(3)(iv).

Corresponding revisions were made to the material advisor fee requirements of the tax shelter listing regulations.

31 Treas. Reg. § 1.6011-4(b)(3)(ii).

32 Treas. Reg. § 1.6011-4(b)(3)(v).

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